Pipeline pressures – The battle over gas prices in Europe
No one likes getting a gas bill, but Europe’s biggest utilities are especially upset over the sums they must pay gas producers, in particular Russia’s state-backed giant, Gazprom. Some are trying to cut those costs; but with little in the way of leverage over producers their chances of success look slender.
Gas prices in continental Europe are mainly set by a decades-old system of long-term contracts, linked to the price of oil. But in relatively liberalised Britain gas is largely traded at spot prices set by current supply and demand. This handed an advantage to some smaller European utilities with interconnections to the British spot market when, in 2008, gas prices suddenly fell. Their bigger rivals meanwhile suffered. They were saddled with “take or pay” contracts that obliged them to buy fixed quantities of gas far above what they could sell and at prices way above those on the spot market.
The gap between spot and contract prices has not gone away. German firms, which are especially hostage to Russian pipelines, are at a big disadvantage. Yet both Russia and Norway, which supply almost half of Europe’s gas, have shown some flexibility towards their complaining customers. By the end of 2009 European gas buyers were begging for relief, with oil-indexed gas then 50% pricier than spot gas. In response, Norway’s Statoil allowed an element of spot pricing around 25% of oil-indexed contracts for three years. Gazprom responded with a less generous 15-20% allowance.
Since then the Russian firm has been the staunchest defender of oil indexation especially as the oil price has soared. And squeezed utilities are again trying to make it change its mind. Yet negotiations over new gas contracts have foundered. E.ON is taking Gazprom to arbitration. RWE, which favours a complete shift to spot prices, has apparently followed suit. France’s GDF is also considering arbitration. But the process could take years and the Europeans may not win.
Meanwhile Gazprom is doing what it can to cement oil indexation by increasing its grip on European power markets. At the beginning of October the Russian firm said it was interested in buying power companies in Britain, Germany and across Europe. This would reinforce its ability to set gas prices on its terms.Troubles at RWE, Germany’s second-biggest electricity producer, have also played into Gazprom’s hand. RWE is burdened by poor acquisitions, a new nuclear-fuel tax and Germany’s decision to abandon nuclear power which constitutes 20% of RWE’s generating capacity by 2022. On October 6th it said it would continue negotiations begun in July with Gazprom over a possible joint venture to generate electricity from gas and coal. In return for going into business with the Russian gas giant, RWE would likely get cheaper gas, but still on the basis of oil indexation.
A deal between Gazprom and RWE could have big consequences for European energy policy. To reduce reliance on Russia, plans are afoot to run a pipeline from Central Asia. And the main consortium partner in the EU’s preferred proposal, known as Nabucco, is RWE. Yet doubts persist as to how this would be financed particularly given RWE’s parlous state and indeed where the gas to fill such a large pipeline would be found. Meanwhile, another proposed pipeline along Europe’s “southern corridor”, called South Stream, which would run from Russia to Western Europe, subsidised by the Kremlin, looks set to go ahead—making Europe even more dependent on the Bear.